![]() There are many ways in which the DCF model can be used. It is often set at 10, which is the average life expectancy of a company. The number of periods is the number of years over which the cash flows are expected to occur. The discount rate can also be set at the weighted average cost of capital (WACC), which is the average of a company's cost of debt and cost of equity. The discount rate is often set at the investor's required rate of return, which is the minimum return that they require in order to invest in a company. The discount rate is the rate at which future cash flows are discounted back to their present value. The cash flow that is being discounted can be from any source, such as earnings, dividends, or even cash that will be generated from the sale of an asset.įor example, if a company is looking to invest in a new factory, the cash flow from that investment would be the revenue generated from selling the products produced by the factory. There are three main components to the DCF formula: cash flows, the discount rate, and the number of periods. The discounted cash flow (DCF) formula is as follows: Understanding the Components of the DCF Formula In particular, the model relies on a number of assumptions that may not always hold true in the real world. The DCF model is a powerful tool for valuing companies, but it also has its limitations. This is due to the time value of money, which states that a dollar today is worth more than a dollar in the future because the dollar can be invested and will grow over time. This present value can then be compared to the current market price of the stock in order to determine whether it is under- or overvalued.ĭiscounting cash flows is important because it takes into account the fact that money today is worth more than money in the future. In other words, the DCF model discounts a company's expected cash flows in order to arrive at a present value that reflects the time value of money. The model is based on the principle that the value of a business is equal to the present value of its future cash flows. ![]() The Discounted Cash Flow (DCF) model is a valuation method used to estimate the intrinsic value of a company. What Is the Discounted Cash Flow (DCF) Model?
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